Does Controlling Shareholders’ Financial Risk Affect Auditors’ Perceptions of Firms’ Financial Reporting Risk? Evidence from Share Pledging

49 Pages Posted: 8 Nov 2018 Last revised: 24 Jun 2020

See all articles by Ke LIAO

Ke LIAO

Wuhan University

Muzhi Wang

Central University of Finance and Economics (CUFE) - School of Accountancy

Deren Xie

Tsinghua University

Dengjin Zheng

Central University of Finance and Economics

Date Written: September 1, 2018

Abstract

We examine whether controlling shareholders’ financial arrangements and financial risk affect auditors’ assessments and perceptions of firms’ financial reporting risk. Adopting a sample of Chinese firms covering the years 2003 to 2016, we find that audit fees are higher for firms where controlling shareholders have shares pledged as collateral to secure their private debt. This effect is more pronounced with Big Four auditors, newly assigned auditors, and firms with opaque information environment. We also find that firms with share pledges have more: earnings management, related-party guarantees and transactions, and a higher likelihood of irregularity. In addition, we do not find evidence that share pledging impairs auditor independence as proxied by the propensity to render modified audit opinions, which suggests that our results are inconsistent with the collusion hypothesis that auditors charge higher fees to tolerate firms’ aggressive behaviors. Our results are robust to endogenousity and measurement error concerns. Collectively, our results suggest that the uncertainty introduced by controlling shareholders’ pledging increases auditors’ assessments and their perceptions of firms’ financial reporting risk.

Keywords: Share pledge, Financial reporting risk, Audit fees, Controlling shareholder

JEL Classification: H32, M41, M42

Suggested Citation

LIAO, Ke and Wang, Muzhi and Xie, Deren and Zheng, Dengjin, Does Controlling Shareholders’ Financial Risk Affect Auditors’ Perceptions of Firms’ Financial Reporting Risk? Evidence from Share Pledging (September 1, 2018). Available at SSRN: https://ssrn.com/abstract=3267040 or http://dx.doi.org/10.2139/ssrn.3267040

Ke LIAO

Wuhan University ( email )

Wuhan, Hubei Province 430072
China

HOME PAGE: http://ems.whu.edu.cn/en/50/1/11/2018-07-26/369.html

Muzhi Wang

Central University of Finance and Economics (CUFE) - School of Accountancy ( email )

Beijing
China

Deren Xie (Contact Author)

Tsinghua University ( email )

Beijing, 100084
China

Dengjin Zheng

Central University of Finance and Economics ( email )

39 South College Road
Haidian District
Beijing, Beijing 100081
China

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